Antitrust regulators face clashing missions in U.S. cigarette deal

Cigarette maker Reynolds American's (RAI.N) proposal to buy smaller rival Lorillard Inc (LO.N) presents antitrust regulators with a conundrum: Their mandate is to prevent higher prices because of mergers, but U.S. public policy aims to make cigarettes more expensive to discourage smoking.

Reynolds, the No. 2 U.S. cigarette maker, said in July it would buy No. 3 Lorillard for $27.4 billion.

Altria Group (MO.N), which owns Marlboro, has a 49 percent U.S. market share, followed by Reynolds at 26 percent and Lorillard at 14 percent. The deal would leave 90 percent of U.S. cigarettes made by two companies, a very concentrated market.

Market share is "clearly up in the problem area," said Herbert Hovenkamp, law professor at the University of Iowa.

"The offsetting consideration is if they will be able to convince the Federal Trade Commission that competition between two more or less equal firms will be more strenuous than between one larger and two smaller firms," he said. "Recently, the agencies have been skeptical of these arguments."

Four of seven antitrust experts interviewed for this story said the FTC could stop the deal. One thought it would be approved with significant divestitures and two declined to say which way the ruling would go.

The FTC aims to prevent mergers that cause higher prices. But both the federal government and the states have taxed cigarettes heavily for years to fund health programs, and because pricier cigarettes are thought to discourage smoking.

Alcohol sales are also subject to "sin taxes", and regulators have been willing to fight various alcohol mergers that have had the potential to raise prices, said Andre Barlow of Doyle, Barlow and Mazard PLLC. "I would think that they would remain consistent."

Reynolds said it was optimistic the deal would be approved. "We continue to move forward with the process and we are confident that the deal will close sometime in the first half of 2015," spokesman David Howard told Reuters.

The FTC has reviewed two major cigarette mergers in the past 20 years.

In 2004, it allowed R.J. Reynolds to buy rival Brown & Williamson, without divestitures. An expert familiar with the FTC at the time said at least some commissioners would not consider using agency resources to litigate to keep cigarettes cheap.

In 1994, the commission sued to stop British American Tobacco's $1 billion purchase of American Tobacco. The two sides eventually settled, and the merger went forward.

A person knowledgeable about the thinking of current FTC decision-makers said at least some believe it is important for the agency to prevent a rise in cigarette prices to protect the poor and uneducated, even if that contradicts public health goals.

Data from the Centers for Disease Control show that smoking is increasingly limited to this vulnerable group.

The FTC has also taken action against cigarette companies. In 1997 it sued, alleging that Reynolds' Joe Camel cartoon character was illegally used to market to children. The agency continues to monitor cigarette advertisements.

"The FTC has been a leader in preventing tobacco use by children," said Matthew Myers, president of the Campaign for Tobacco-Free Kids. "The FTC should have the judgment to realize that the goal with tobacco is not to do anything that would make prices cheaper."

Overall, cigarette sales are dropping nationwide, and the industry's future customer base seems to be as well.

In 1992, 28 percent of U.S. 12th graders smoked, while 16 percent do today, according to the University of Michigan's Monitoring the Future study.

Reynolds and Lorillard attempted to resolve the biggest overlap among their brands, in electronic cigarettes, when they announced the merger.

Reynolds, which owns the VUSE e-cigarette, said it would sell Lorillard's blu brand to Imperial along with four cigarette brands: Kool and Salem, both menthol, Winston and Maverick.

But Reynolds would keep Lorillard's dynamic Newport menthol brand, which is popular with African-Americans and whose market share is rising. Newport is the nation's second most popular cigarette, the company said in its annual report.

David Balto, a former policy director at the FTC, said the planned divestitures are inadequate. "The brands that are being offered face extinction in a decade. They're really trivial," he said.